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The Best Way to Lose Your Home

posted on November 14, 2011

If you read finance related discussion boards and blogs, you must have read discussion on a confession in New York Times by a financial planner about how he lost his home in the real estate bubble in Las Vegas.

Long story short, the financial planner bought a home with 100% financing for $575,000, refinanced it with a negative amortization loan when the home’s value went up and took $200,000 cash out to fund his business. He finally sold it for $531,000 in a short-sale when he moved out of Las Vegas.

There are many negative comments on this story. Many said it shows financial planners aren’t any smarter or more savvy about financial matters than the average Joe Six-pack. Some said this planner isn’t qualified to give financial advice. These comments miss the point entirely.

Financial planners are humans. Humans make mistakes. It’s important to learn from our own and others’ mistakes.

In addition, this planner actually handled the bubble very well. He didn’t know it was a bubble. Even if he knew, he didn’t know when it was going to burst. Just like today we don’t know whether bonds or gold are in a bubble. People who said bonds or gold are in a bubble have been proven wrong so far. They either lost money or lost opportunities to make money.

Shorting on suspicion of a bubble would be a mistake. The market can stay irrational longer than you can stay solvent. Not participating in a suspected bubble would also be a mistake. Bill Gross is a prime example. People accuse Bill Gross as an incompetent money manager for not staying in Treasuries.

The best way to profit from a bubble would be exactly as this planner did: maximize leverage for the upside and protect yourself from the downside. I’m not saying this planner planned this way but I don’t think he’s as foolish as people think. Given the options put in front of him, he made very good choices.

When a bank offers 100% financing on a house you think will go up in value but you are never sure, putting 20% down would be foolish no matter which way the market goes. If the price goes up, you make more money with 100% financing because you have more leverage. If the price crashes, you lose your down payment if you put 20% down. Of course you should do 100% financing.

After the home price went up and the bank offered you a cash-out refinance with negative amortization (pay less than the interest on the loan), not doing the cash-out refinance or paying down the mortgage would be a mistake for the same reason. If the price keeps going up, you increase your return on investment with an increased leverage from cash-out and negative amortization. If the price crashes, you already locked in a profit at the high watermark from the cash-out.

Our financial planner could’ve done better if he sold the home at the top of the market, but that’s asking for too much. Nobody can time the market perfectly except for being extremely lucky. That’ll be like demanding that Bill Gross times the exit from Treasuries at the exact top. I don’t expect Bill Gross to be able to do that.

The end result was almost exactly as planned, whether the financial planner planned it or not. The planner sold the home in a short-sale and ended up with a thriving business, partly thanks to the $200k seed capital from the banks. Now the planner is writing for New York Times and going on public radio. His book will come out in January. I heard William Bernstein said something nice about it.

Short of timing the market top, I can’t think of any better way to “lose” your home. Think how many financial planners are in this country. How many of them get $200,000 free capital from the banks? How many of them get publicity in New York Times? How many of them appear regularly on public radio? How many of them will have a book published by a major publisher, which will help bring in more business?

To top it off, now he should repay the bank for the loss from the short-sale, with interest. This way he’ll be able to claim complete redemption with a clear conscience for taking responsibilities for his mistakes. With a gross revenue of $840,000 a year ($56 million under management at 1.5% fee), he can afford it. Just think of it as marketing expense.

Our financial planner is smarter than you think. 100% financing, cash-out refi, and negative amortization loan aren’t really mistakes. They are exactly the right moves in a bubble. A drop in the credit score as the consequence, you say? The capital, the publicity, the book deal, and the business make it so worth it. The credit score will come back up over time. Who cares about credit score anyway when your business brings in $800k a year?

His clients are really lucky to have him as their advisor. The planning skills are worth at least twice the 1.5% asset management fee. All the negative comments just don’t get it.

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“If the price goes up, you make more money with 100% financing because you have more leverage.” Doesn’t this depend on the relative interest rates of the mortgage and rates of return on investment of capital invested in something other than the house?

TFB, I agree with your analysis. My question to you (and this is a serious question, not facetious) is: assuming you live in a non-recourse state, do you keep your home as leveraged as possible at all times to avoid exposure to a drop in its value? That would be the rational move, right?

@John Reynolds – If the value of a home goes up from $500k to $600k, and you had 20% down ($100k), you make 100% return on your down payment. If you only had $10k down, you make 1,000% return on your down payment. That’s what I meant. Of course in terms of absolute dollars, you are correct: if you borrow $90k more, you pay interest on that $90k, and you need to earn more on the $90k than the mortgage interest rate, but having less money tied to the house greatly reduces your risk.

@Matthew – I didn’t and that was a mistake. If another bubble comes, I should.

No, I think you missed the point of the comments. Most people can understand that financial planners are only human and thus capable of making mistakes like the rest of us. A lot of comments on various boards relating to this story are disgusted by this planner’s choice to use these financing tools to support an unsustainable, greedy lifestyle for which the bill was passed onto society. Further, the planner writes his story as though he’s learned a huge lesson from this while currently planning poor advice to his clients and charging ridiculous fees for that advice. His book is opportunism at it’s best and the attention he receives only helps him. I am disgusted by him.

Just because you don’t put a dollar sign next to what he lost because you focus on his business gains does not mean he did not loose anything. In addition, his contrition came across very hollow and unauthentic. He lost a lot of respect in the eyes of many commentators. Private Profiteering on the backs of social losses is disgusting to many. In your eyes this may be conflating issues, in others, it is the stark truth.

Even though he (financial planner) may have benefited financially doing what he did. I would lose trust in him and fire him for his moral values. It is no different than what A. Mozillo, K. Lay etc..did, It is a moral “crime” just because he wasn’t prosecuted doesn’t make it victimless or right. He needs to “earn” your money, not shirk financial responsibility.

Isn’t that what you want a financial advisor for?

If you just want to make money, there are more than million ways to do it legally but unethically. For example overhype a company and get investors only to file bankruptcy once you have the investors money.

I know plenty of people who profited from the real estate bubble in Las Vegas, NV. I would rather listen to them.

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